The market remains in a narrow trading range, near the record highs. There have been some relatively minor leadership changes. This reflects not investor complacency, but intense disagreement about how to interpret data and events. Each viewpoint has a history, a philosophy, and problem something to sell!
The power to set the agenda and to frame the issues is more important than most understand. The punditry will not be explaining this in the week ahead, but they will be practicing it. By watching for it (or simply ignoring financial news) you can avoid the biggest current investment danger:
Don’t Get Framed!
Last Week Recap
In my last edition of WTWA I asked what might disrupt the delicate balance of news. That was a good question. Despite plenty of discussion it remained unanswered during my vacation. Earnings are strong as are economic reports. The only changing elements are the subjects of tweets and assorted corporate issues.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. I especially like the version updated each week by Jill Mislinski. She includes a lot of valuable information in a single visual. The full post has even more charts and analysis, including commentary on volume. Check it out.
The market was headed for a nice weekly gain until Friday’s trading. The late-day rebound held the week’s loss to 25 bps. Despite the swingy chart the range for the week was only 1.3%. I summarize actual and implied volatility each week in our Indicator Snapshot section below. Volatility remains well below the long-term range.
In the same post Jill includes an update on drawdowns. This helps us see the nature of this rally – occasional declines even in the context of a major stock rally.
Mrs. OldProf and I enjoyed our trip. For me it had the customary effect of forcing my mind away from markets. It helped that our timing was good; the market increased by 1% while we were gone and maintained low volatility. Economic news remained solid, as did corporate earnings reports. If you were going to take some time off, this was a good choice.
I used some extra thinking time to consider priorities. I am committed to making sure that WTWA has timely information on broad themes as well as highlighting specific news and ideas.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
When relevant, I include expectations (E) and the prior reading (P).
New Deal Democrat’s regular weekly review of high-frequency indicators remains positive overall but has slipped to neutral for those in the long-term forecast. A small change could send this forecast into negative territory.
- The JOLTs report reflects continuing structural strength in the labor market. The Washington Center for Equitable Growth has the best chart pack on JOLTs. The quit rate remains at historically high levels (positive, since this implies worker confidence in the job market). The Beveridge curve shows that conditions are at pre-recession levels. With the tighter labor market, job openings are now yielding fewer hires.
Larry Williams (Daily Speculations) provides anecdotal support with a sign he is seeing everywhere on his travels. He notes that some include bonuses for immediate applications.
- Business owners remain highly optimistic. David Templeton (HORAN) reports the data from Gallup. He notes that finding qualified workers remains the biggest challenge for small-business owners.
- PPI remains tame with a headline increase of 0.0% and 0.1% on the core. E= 0.3 and 0.2. P= 0.3% on both.
- Initial jobless claims remain at record lows, this week only 213K.
Companies remain optimistic. Avondale Asset Management reviews transcripts from earnings calls and presentations. Their full report is loaded with excellent examples. Their overall summary?
Optimism abounds as the boom times in the economy persist. As a result, companies have lots of positive commentary and reasons to be excited. Despite this, talk of trade war hangs over the markets. Few people talk about risk, but history dictates that markets are cyclical.
- Real wages have declined on a YoY basis, despite the increase in aggregate payrolls. New Deal Democrat highlights the 2.9% CPI increase and compares it to the gain of 2.7% of non-managerial workers. He explains why the reported aggregate wage growth does not tell the whole story. Eddy Elfenbein observes that most of the increase came from more than six months ago. The July report registered a gain of 0.17%. He notes, “That’s still tame.”
- Rail traffic was higher YoY, but Steven Hansen (GEI) notes that the rate is decreasing. Read his full post for deeper analysis, several sources, and plenty of charts.
Even the bad news this week was mostly neutral. Feel free to add items I missed in the comments!
The biggest local news on my return was the violent weekend. There were 74 gunshot wounds. Chicago Police Superintendent Eddie Johnson said that “20 percent” of the 11 people who died due to gun violence last weekend were participating in a “large outdoor unsanctioned gathering.” (Fox News). Many gatherings grow rapidly via social media and some become gang targets.
There was a lot of political finger-pointing last week, but little real substance. I suspect WTWA readers may not find Superintendent Johnson’s 20% analysis to be very convincing.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
The calendar has important housing data, retail sales, and the preliminary August report for Michigan sentiment data. Important earnings reports continue.
Nothing seems more significant than the events that occurred in the recent quiet period. The delicate balance continues.
Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.
Next Week’s Theme
While I checked in during my vacation, I took time off from my intensive reading and stock research. There was plenty of important news, but the market reaction was muted. There was plenty of commentary, of course, but nothing fresh. The most important consideration for investors is how this might affect your personal choices. On Friday, someone asked me what I made of the day’s action! There are better things to do than worry about a tweet with no policy specifics, related to a single country, and apparently leading to a move of less than one percent. One pundit got it right: It was a slow summer Friday in search of a story.
The financial news – at least for the moment – is not much about news. There is plenty of opinion, with few neutral sources. Everyone wants to set the agenda and to frame the issues in a way friendly to their viewpoint and business. If you understand this, it is the first step toward self-protection.
Don’t Get Framed!
Here are the most important misleading frames:
- The bad driver, constantly watching the rear-view mirror. Adherents of this approach believe the best way to determine future expectations is to look at the past, often an arbitrary period. This may include considering past earnings, past business cycles.
- The anthropologist, who insists on humanizing the market. Statements like “This market is trapped in a narrow range and just wants to break out” provide no analytic content. Since most people believe they understand human behavior, but do not know much about group behavior, these statements have unwarranted appeal.
- The announcer interprets daily market action as if it were a sporting event. “The bulls need to hold 2820 or look out below.”
- The breathless newscaster exaggerates the importance of minor events or modest market moves. “The Dow is 40 points off the low of the day!”
- The ideologue uses political viewpoints as a basis for finding investments. Just because a policy is endorsed by a leader you favor, does not mean that it will be effective. And vice-versa.
- The weatherman makes lists of headwinds or tailwinds. These are especially easy to distort. There is so much to choose from and any can be made to seem important.
- The rationalizer makes excuses for poor decisions. In this viewpoint it is better to be thought right than to be right. The most popular excuse is to blame everything on the Fed.
These characters, of course, are playing upon your confirmation biases – as well as their own. Farnam Street has a helpful, brief discussion, including this quote from Warren Buffett:
“What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.”
How else can we explain those who adhere to broken methods, year-after-year, despite the results?
I have some personal observations and an alternative approach in today’s Final Thought. Feel free to join in with suggestions of more species of framers.
We follow some regular featured sources and the best other quant news from the week.
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.
The Indicator Snapshot
Short-term trading conditions continue at highly favorable levels. Actual volatility remains low. The VIX (despite a post-January low) is once again higher than reality.
Some readers have requested a retrospective indicator snapshot from 2008, and we are working on that project.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score.
Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. With several recent big reports, it is time for another look at their excellent Big Four chart, focused on the key elements for recession dating.
These series are all better interpreted in terms of trends, but even the monthly data points show very few declines this year.
Bespoke notes the decline in the VIX measure of volatility.
Insight for Traders
Check out our weekly Stock Exchange post. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we asked whether the market was in a lull before the storm, and what traders might do about it. In addition to expert commentary on our theme we discussed some of our own current picks. The ratings from Felix and Oscar this week feature the DJIA. While our entire team pitches in, Blue Harbinger is the editor for this information and ringleader for the group discussion.
While the series emphasizes trading, investors might want to check it out. The methods reduce risk through diversity and (for most people) are appropriate for those needing a boost in returns in their IRA.
Insight for Investors
Investors should have a long-term horizon. They can often exploit trading volatility.
Best of the Week
If I had to pick a single most important source for investors to read this week it would be Dr. Brett Steenbarger’s post about the need for discipline. As usual, his audience consists of traders, but the logic is also important for investors. It is also a perfect fit for our theme. He begins with the idea that you must master your thoughts. If not, you will not be able to control your actions. After some helpful examples he notes the important stage of learning discipline:
Across performance activities we can see that disciplined performance is a necessary phase of development. The basketball or football player learns to follow a game plan, not just do what they feel like doing. The poker player learns to fold when the cards aren’t right. It’s common for developing psychologists to learn their craft from manuals that are research-validated and that give them a game plan for helping people with various problems. Discipline is all about sublimating the ego to sound rules and principles.
Once you have a firm foundation, you can consider some exceptions.
Many investors swear by the dividend growth stock approach. Chuck Carnevale goes one better by identifying candidates that have attractive valuations. He notes that this helps long-term performance and lowers risk. You will be familiar with some of the ideas, but not others.
Morningstar discusses ten undervalued stocks with “exponential” growth potential. When such lists have some names I already own, it increases my interest in seeing the rest – in this case eight of them.0
Dividend Sensei combines an instructive method, excellent sources, and analysis to come up with a list of 10 Blue Chip stocks.
Stone Fox Capital likes both the earnings report and the improved guidance for 2018 in CenturyLink (CTL).
Marc Gerstein’s first-rate screening techniques lead us to building supply distributor HD Supply (HDS). Marc consistently finds interesting ideas that you are unlikely to see elsewhere!
James Picerno notes the improvement in the “value sector” of U.S equity investing. August accelerated the trend, but there is still a big gap.
Validea provides some rules to help in avoiding the dreaded “value trap.”
Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily considers a wide range of sources as well as his own take on an important issue. It is interesting to financial advisors as well as the DIY investor. In one post this week, sparked by a NYT article about bankruptcies among seniors, he takes up the need for frugality in retirement.
Abnormal Returns is an important daily source for all of us following investment news. His Wednesday Personal Finance Post is especially helpful for individual investors. There were many helpful links this week, ranging from retirement issues to how young people should get started. My favorite covered a topic relevant to many of my clients, blending some work with retirement. Morningstar’s Mark Miller describes how you can reduce your overall workload and remain engaged. Extra income is helpful as well.
Watch out for…
Companies that need more than operational results. DM Martins Research analyzes Azul (AZUL), a young Brazilian airline. The traffic, capacity, and load factors are all better. But…… “as Friday’s 6% share price drop reminded me vividly, the stock is still highly sensitive to factors outside the company’s control, including the ups and downs of the Brazilian Real, crude oil prices and investor behavior (e.g. profit taking, risk-off attitude)”.
Gold, when economic strength is strong. Scott Grannis explores the surprising relationship between gold and TIPS. He suggests that those interested in gold purchases may see lower price opportunities.
The best way to avoid the seductive pull of the carefully-framed arguments is to develop an effective method. Then be disciplined in following it.
The selection method. Stick to fundamental valuation of your long-term investments. You are not trying to outguess Mr. Market’s latest mood.
- The reward for stock ownership is a flow of earnings. Look forward in your analysis. If it is a cyclical stock, look for solid business cycle evidence to help your evaluation. Consider debt, competition, and business trends. Find stocks that are cheap on a price to earnings basis. In some cases, it is better to use cash flow or enterprise value. You can learn to do this, but it requires study and the willingness to follow a group of watch-list stocks. You cannot merely follow tips. The tipster might not be around to tell you when to exit! Following Brian Gilmartin’s excellent updates helps in this task. Anyone tracking his coverage of growth estimates has been on the right side of the market.
- Compare your stock portfolio with other asset choices but do so carefully. Asking your list of “stock questions” about high-yield bonds, rental property, or structured products is not easy. Do not take a stated yield at face value.
Analyzing risks. Understand the risk types and implications.
- Headline risk is usually just noise. You can consider it if there are quantifiable impacts on the economy or corporate earnings, but not merely because it sounds bad. And, there are always those who will tell you that a certain event is “just the start.”
- Market volatility is often described as risk but is not actually important unless you need your investment funds very soon. You must expect declines of 15 – 20% in your stock portfolio as a part of long-term investing. Look at the drawdown chart in today’s introduction.
- Recession risk and financial stress are important. These are almost always associated with the largest market declines.
Just as you have a method for evaluating potential investments, you need a process for risk recognition. That is the purpose of the Quant Corner in WTWA.
The example of the “bad driver” reminded me of a childhood experience with my dad. While I was not yet of driving age, he occasionally suggested some great techniques. We were rolling along a state highway with no stop signs or traffic signals ahead. There was little traffic. Suddenly, Dad hit the brakes, slowing before we passed an intersecting farm road. The vehicle on that road just blew through the intersection, ignoring his stop sign. Dad had spotted him a ways back and became suspicious. His risk recognition skills were great in many fields. In this case, it probably meant that I am here today to write about it!
[This is a crucial time for investment decisions. If you are flying solo, you might want to request my papers on risk or the top pitfalls for individual investors. If you are concerned that you do not have a good risk/reward portfolio, or one suited to your needs, feel free to ask us for an analysis. For any of these just email main at newarc dot com].
I’m more worried about:
- The lack of compromise about anything. The time will soon come when this is essential.
- The growing focus on the mid-term elections. This is never a positive for policy formation, and it is shaping up to be nasty.
I’m less worried about:
- The actual tariff effects. There seems to be some progress in the Mexico negotiations. Investors have become optimistic about China. We’ll see if they are right.
- Earnings reactions. Stocks with solid earnings and outlook have responded positively, although perhaps not as much as deserved.